Materials ETFs Surge Amid Rate Cut Hopes

A lower U.S. dollar increases demand for commodities

Sluggish gold and oil prices have limited year-to-date (YTD) gains in the basic material sector. Although the segment has recorded a respectable 6.6% return, its performance falls well short the S&P 500's 13.43% gain.

Ironically, the primary catalyst that caused the stock market to have its worst May since 2010, in a roundabout way, has given the basic materials sector a much needed boost in the first trading week in June. How so, you ask? Federal Reserve Chair Jerome Powell signaled that he is open to cutting rates this year if ongoing trade conflicts with China and Mexico slow economic growth.

"We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion," Powell told a conference at the Chicago Fed, according to Bloomberg.

The possibility of rate cuts later in 2019 has put downward pressure on the U.S. dollar this week. A lower dollar, in turn, helps the basic materials sector by making it cheaper for foreign buyers to purchase commodity-related materials priced in dollars, increasing the demand for products these companies sell.

Traders can play the recent strength in basic materials stocks by using one of these three exchange-traded funds (ETFs). Let's review each fund and its chart.

Materials Select Sector SPDR Fund (XLB)

Created 21 years ago, the Materials Select Sector SPDR Fund (XLB) seeks to provide similar returns to the Materials Select Sector Index – a benchmark comprising materials stocks in the S&P 500. XLB's top three allocations include Linde plc (LIN) at 16.51%, DuPont de Nemours Inc (DD) at 8.75%, and Ecolab Inc. (ECL) at 7.60%. The fund has an enormous $3.1 billion asset base and suits all trading styles with its 0.02% average spread and daily turnover of 6.2 million shares. Despite the positive start to June, the ETF is still down 1.29% over the past month as of June 7, 2019. XLB charges a low 0.13% annual management fee and offers a 2.13% dividend yield.

XLB shares retraced lower for about six weeks after a "golden cross" signal appeared on the chart – when the 50-day simple moving average (SMA) crossed above the 200-day SMA. The selling ended abruptly this week, with the price jumping over 8% in the first four days of June on above-average volume. Traders should buy dips to $55, where the fund finds support from the November and December swing highs. Think about booking profits on a test of the 52-week high at $60.39 and cutting losses if the price closes below the 200-day SMA.

Chart depicting the share price of the Materials Select Sector SPDR Fund (XLB)

Invesco S&P 500 Equal Weight Materials ETF (RTM)

With assets under management (AUM) of $118.11 million, the Invesco S&P 500 Equal Weight Materials ETF (RTM) aims to track the performance of the S&P 500 Equal Weight Materials Index. The underlying index represents an equal-weighted version of the materials components of the S&P 500. RTM suits traders who seek a less concentrated bet on the materials sector and want risk spread evenly across the basket of stocks. Think about using limit orders to minimize slippage, as the fund trades just over 6,000 shares per day and has an average spread of 0.23%. As of June 7, 2019, RTM pays a 1.99% dividend yield, has a competitive 0.40% expense ratio, and is down 3.31% over the past month while returning 10.63% YTD.

The RTM share price trended steadily higher between late December and mid-April before pulling back significantly throughout May. Buyers have returned to the ETF in force this month on hopes of a Fed interest rate cut and increased demand for precious metal commodities amid elevated trade tensions. Instead of chasing the price, traders should look for an entry point between the two moving averages in the $103 to $105 range. Set a profit target near the April swing high at $110 and keep a tight stop-loss order under the June 4 low at $101.62 in case the price fails to continue its upward momentum.

Chart depicting the share price of the Invesco S&P 500 Equal Weight Materials ETF (RTM)

Invesco DWA Basic Materials Momentum ETF (PYZ)

Invesco DWA Basic Materials Momentum ETF (PYZ) attempts to offer similar investment results to the Dorsey Wright Basic Materials Technical Leaders Index. Formed in 2006, this fund provides traders with an alternative play on the materials space by selecting stocks based on price momentum. It specifically targets the chemical industry, giving a 32.49% weighting to commodity chemicals, a 16.93% weighting to specialty chemicals, and an 8.96% weighting to diversified chemicals. Key holdings in its portfolio of 49 stocks include Air Products and Chemicals, Inc. (APD), FMC Corporation (FMC), and Ashland Global Holdings Inc. (ASH). Traders need to be mindful of the fund's lower liquidity – it averages daily dollar volume of roughly $133,000. The ETF has fallen 7.61% over the past month but remains in the green YTD – returning 7% as of June 7, 2019. It charges an annual management fee of 0.60%, slightly above the 0.51% category average.

PYZ formed a broad inverse head and shoulders pattern between October and April but subsequently broke down below the formation's right shoulder in May. The early June rally indicates that the price wants to make a run toward a long-term downtrend line that extends back to September 2018. Traders who intend on taking a position may want to enter at the current price, as the relative strength index (RSI) gives a reading well below overbought territory, allowing the price ample room to move higher before consolidating. Consider setting a take-profit order near the two swing highs that formed earlier this year at the $62 level and placing a stop slightly below Tuesday's wide-ranging day. Manage risk by amending the stop to the breakeven point if the price moves above $60.

Chart depicting the share price of the Invesco DWA Basic Materials Momentum ETF (PYZ)
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